Average net annual rate of return
The average net annual rate of return method is a variation on the average gross annual rate of return method. It assumes full recovery of the whole project investment, including fixed asset costs (such as buildings and machinery), out of net cash flows before calculating the rate of return on the investment. Because of this, the average annual rate of return is expressed as a percentage of the average capital employed instead of as a percentage of the original investment.
This can be illustrated with the same two examples that I used previously.
The variables in the equations stand for the following:
- PI is initial project investment
- NCF is positive net cash flow
- L is project life
- ANCF is average net cash flow.
This is then divided by the average capital employed (ACE), which in this case is calculated on the basis of the initial outlay of £100 000, and a final outlay of zero, that is
So the overall result from the net method identifies project B as the better option, the same as from the gross method.